After doing this activity, students will be able to understand the nature of relationship between bonds price and the factors affecting it.

GDB:

Theoretical literature on bonds valuation concludes that “all other things being the same, the price of a bond is an increasing function of the frequency of coupon payments”. This is somehow true in a sense that effective annual yield is higher for interest rate compounded more than once (semi-annually, quarterly, monthly) in a year. This relationship can be understood in a way that greater the number of compounding, higher will be the total coupon payment on bonds and it will have positive effect on market price of bonds. But bonds prices are not only influenced by compounding periods in a year, there are other factors playing the role such as yield to maturity, time to maturity and coupon rate. In practice, although some bonds make coupon payments on annual basis while mostly pay on semi-annual basis. It is therefore pertinent to know how frequency of coupon payments influence bonds prices. In real world situation, bonds prices not necessarily increase with the number of times coupon payment is made within a year as suggested in theory.

Following data pertains to a 1-year corporate bond having face value of Rs.1000 offering coupon rate of 10% compounded annually and semi-annually to its bondholders selling at different prices in the bond market as given below:

Yield to maturity (YTM)

Coupon Payment

Coupon rate

Compounding period

Present value of interest payment

Present Value of par value

Bond’s market price (Rs.)

6%

100

10%

Annually

94.34

943.40

1037.74

100

10%

Semi-annually

95.67

942.60

1038.27

15%

100

10%

Annually

86.96

869.57

956.52

100

10%

Semi-annually

89.78

865.33

955.11

10%

100

10%

Annually

90.91

909.1

1000.00

100

10%

Semi-annually

92.97

907.03

1000.00

Requirement:

Explain the relationship of bond’s market price with frequency of coupon payments by considering the factors influencing the direction (increase/decrease/no change) of relationship.

Special Note:

No calculations or supportive working required.

Your answer should be to the point and must satisfy the question requirement.

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Note:

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there is an inverse relationship between bond price and frequency of coupon payment because of more compounding affects. But this relationship is depend on market interet rate as well as time to maturity

there is an inverse relationship between bond price and frequency of coupon payment because of more compounding affects. But this relationship is depend on market interet rate as well as time to maturity

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